Speculators are always looking for opportunities to generate the return by presuming the risk. These individuals have a high appetite for risk and always looking for opportunities that generate higher returns.
The working model of the speculators is to invest for a short time, make money and find other opportunities.
Speculation is a very sensitive activity that requires strong market understanding and trading at the appropriate time. If the speculator does not understand the market dynamics strongly, he/she might be left with an empty pocket.
How speculation impacts the market
The speculation improves the liquidity, mobility and brings stability in the prices of the security. The rate of trading increases in the market, which encourages investors to trade in the market.
Hence, the speculator is expected to increase the overall health of the market by increasing trading activity.
Further, the speculator selects the high-risk securities and leaves the rest for the normal investors. Hence, stable securities with relatively lower risk are available for the investors.
Types of the Speculator
A bullish speculator predicts an increase in the price of security in the recent future. The purchase of the security is made keeping in mind that the price will be increased and profits can be made easily.
It’s also called bull speculation because it’s like a bull with the ability to throw the victim very fast and the bullish speculators also want to generate profits fast.
The bearish speculation is when the speculator expects the price of a specific security to fall in the future.
To benefit from the expected decrease of the price, they enter in a contract to deliver the security in the future while locking the price of today.
If their speculation is correct, they purchase the security at a lower price (as expected) and sell at the higher price, which was locked before. They might be at a loss if the costs increase in oppose to their expectation of the decrease.
If the bearish cannot provide security on the fixed date of the future, this condition of the speculator is called lame duck.
The stag is when the speculator applies for allotment of the new securities. They expect to sell the security at a premium in the short future. They earn profits if they sell the securities at prices higher than the prices of the allotment.
The stag is more bullish that expects an increase in the prices. However, the stags deal in the allotment of the securities for the new companies.
Difference between speculators and investors
The main difference between speculators and investors is based on the risk behavior of the investor. The risk appetite of the speculators is higher, and they try to make a profit by presuming the risk.
On the contrary, the investors try to maximize the rate of return with effective management of the risk.
Difference between speculators and Hedging
The speculators purchase the security to make a gain by presuming the risk associated with it. It’s the business model of the speculators to invest for a short time and make profits.
The only purpose of the speculators is to make a profit in a short time.
On the other hand, the hedgers protect themselves from the risk by investing in the related security. So, the purpose of Hedging is to protect the business from risk.
Advantages of speculators
Increase in the liquidity
The speculators increase the rate of trading in the market. They keep on purchasing and selling the securities in the market.
This increases liquidity.
Another point to note is that the speculators are always looking for security, which is expected to show a massive increase quickly.
Hence, overall activities of the market increase, which leads to improved liquidity and an increase of the index.
In other words, the sellers can quickly sell their security in the market because the market is experiencing higher demand due to the existence of the speculators. Similarly, the same is true in the case of buying the security.
As the speculators are always looking for security which is higher in the risk. So, they shoulder the higher risky securities, and the chance for other investors in the market decreases.
In other words, average investors can easily purchase securities that are lower in risk and in line with their risk appetite.
In other words, speculators act as an insurer by providing price insurance/hedging services to the market. In addition to this, the speculation helps to stabilize the prices of the securities in the market.
Disadvantages of speculators
The speculators may be the cause of the economic bubbles. The economic bubbles arise in the market when the price of the securities exceeds in comparison with the intrinsic value of the security. So, the speculators may actually cause inflation in the prices of the security.
If there is speculation in the market, the words of the mouth may spread about some specific security and increase the prices of the security artificially.
The bursting of the bubble might actually be a cause of the loss for the normal investor who had not opted for the speculation.
The speculative activities in the market may be the cause of the price fluctuation and volatility. Although, opinions do vary on the volatility as the provision of the capital may help to bring stability in the price.
However, if there is excessive speculative activity and positive feedback about speculation in the market, it may divert the crowd to participate in the speculation, So, the prices may become more volatile as a result.
To be conclusive, all the speculators are the investor but not all investors are speculators. Speculation plays important role in the effective operations of the market by boosting liquidity and shouldering the higher risky securities.
However, the speculators might be the cause of the economic bubble as the price of the security might inflate due to higher demand, and excess speculation can cause volatility.
The speculation can be bullish when the speculator expects an increase in the price of the security and bearish when the speculator expects decreases in the price of the security.